European automotive leveraged finance issuance has proven robust in the past two years with issuers finding the market supportive of the industry through lockdowns and eager to finance its post-pandemic recovery.
Automotive leveraged loan issuance in Western and Southern Europe delivered its two highest ever annual totals in 2020 and 2021, with issuance of US$23.9 billion and US$21.7 billion, respectively. High yield activity for the European sector was equally resilient, with US$12 billion issued in 2020 and US$9.6 billion in 2021, representing the second and third best annual totals on Debtwire Par record.
Despite the strong appetite for automotive debt in the past 24 months, the industry entered 2022 in a state of flux.
Car sales, which rebounded as economies around the world reopened, were forecast to increase by 7.5% in 2022, according to the Economist Intelligence Unit (EIU), exceeding 2019 levels. Supply chain disruption and a shortage of semiconductors, an essential automotive component, however, have put the industry under extreme pressure to meet this demand. Yet, the first two months of 2022 were better than expected.
Events in Ukraine have significantly hit the automotive industry. Supply chains have been affected as Ukraine is a hub for wiring harnesses. This has already had particular impact on European car manufacturers, some of which have announced temporary production stops. Further, the sanctions against Russia, a key export hub, will most likely result in rising raw material prices and could even lead to shortages of raw materials.
In addition to the immediate supply chain headwinds and raw material risks, the industry is grappling with ambitious government timetables to phase out the manufacture of combustion engines in the next 10 to 15 years and transition to electric vehicles.
Electrification: Winners and losers
The general transition will benefit some manufacturers and suppliers more than others. According to the EIU, global electric car sales are expected to outpace overall vehicle sales significantly, with growth of 51% anticipated.
Manufacturers focused exclusively on electric cars, such as Tesla and startup Rivian, have benefitted directly from this surge in sales—at certain points last year, their stock prices exceeded those of significantly larger incumbent automakers.
For car companies that still produce combustion engine vehicles, however, the transition to exclusively electric car production poses significant challenges.
Speaking at a Reuters Next conference at the end of 2021, Carlos Tavares, CEO of Stellantis—the European car giant formed in 2021 following a US$50 billion merger between PSA, the owner of Peugeot and Vauxhall, and Fiat Chrysler—warned that the accelerated move to electric vehicles would impose significantly higher costs on automakers and jeopardize their financial sustainability.
Stellantis has already earmarked €30 billion of investment by 2025 to develop its electric vehicle capabilities and plans for 70% of European sales and 40% of US sales to be low emission cars by the end of the decade. Despite this activity, however, Tavares has warned that the pace and cost of electric vehicle transition demanded by governments and regulators could be too much for the industry to bear.
Electric vehicles are already more expensive to manufacture, with Tavares putting the extra costs at up to 50%. That additional cost is too great to transfer to consumers and will likely lead to automakers either selling fewer, more expensive electric cars or eating materially into margins. Either scenario could lead to job losses and cutbacks. The costs of retooling production lines and upping productivity will push the sector to its limits.
The financial pressures involved in this transition could affect automaker credit quality, as well as the cost and availability of debt finance. The impact on automotive supply chains may be felt even more keenly, with the market bifurcating between component suppliers that will benefit or be unaffected by the shift to electric cars and those that will be adversely impacted. Chip, battery and vehicle interior providers, for example, should find debt markets open and attractive, but suppliers in areas such as power train components used only in petrol and diesel engines are already finding it more challenging to secure debt capital.
Events in Ukraine and the sanctions imposed on Russia may significantly affect these predictions as Russia is an important source of certain raw materials required for battery and chip production. The sanctions imposed on Russia could intensify the chip shortage crisis and affect the supply chain more generally. With key raw materials seemingly more relevant for electric cars and their related batteries, the transition to electric cars may even slow down. It remains to be seen whether this result is offset by the effect of increased oil prices, which make electric cars more attractive.
Generally, the effects of events in Ukraine are more relevant for the European automotive sector than for US-based companies. Within the European automotive sector it is likely that suppliers will—generally—be hit harder than OEMs. We expect the resulting uncertainties and risks will be factored into the debt terms of automotive companies that have exposure to these risk areas.
Embedding ESG criteria
The affected supply chains and the transition to electric vehicles are not the only challenges facing the industry. Auto manufacturers are also working hard to improve their environmental, social and governance (ESG) status and this is adding both opportunities and challenges for the industry.
In the past 12 to 24 months, for example, several automotive manufacturers and suppliers secured ESG-linked financing that reduces financing costs if pre-agreed ESG criteria are achieved.
At the end of 2021, German car group Volkswagen secured its first ever sustainability-linked loan, raising a €1.8 billion three-year loan where interest payments will be linked to targets for reducing its CO2 fleet emissions.
Earlier in 2021, France-based automotive supplier Valeo became the first European automotive supplier to raise a sustainability-linked bond, securing €700 million with a seven-year maturity linked to carbon emissions reduction, while Faurecia, the French automotive technology business, raised the largest ever ESG-linked Schuldschein facility by an issuer outside Germany. Numerous other issuers, including Volvo and Spanish components supplier CIE, also tapped ESG-linked credit lines with success.
Over-eagerness in the industry to present ESG credentials to the market and the potential for greenwashing, however, pose risks to the long-term sustainability of ESG-linked debt provision to automotive borrowers.
The reputational risk to borrowers and lenders if ESG targets are missed is material and work still remains to tighten up the KPIs for ESG in automotive. ESG KPIs and performance will need to extend beyond vehicle electrification exclusively and build in other relevant KPIs to show that automotive ESG claims are credible.